MS-09 : Managerial Economics Solved Assignment Q6

6. Write short notes on

a) The Opportunity Cost Principle

b) Arc Price Elasticity

c) Law of Diminishing Marginal Returns

a) The Opportunity Cost Principle:

Opportunity cost or economic opportunity loss is the value of the next best alternative foregone as the result of making a decision. Opportunity cost analysis is an important part of a company's decision-making processes but is not treated as an actual cost in any financial statement. The next best thing that a person can engage in is referred to as the opportunity cost of doing the best thing and ignoring the next best thing to be done.

1. What you sacrifices the next best choice. To determine opportunity cost we consider only the best of the probable alternatives.

2. As long as resources are scarce, an increase in the production of a good, which necessarily result c a decrease in the production of a good is subject to increasing opportunity cost.

3. Prices are a measure of opportunity cost because they provide information about the value of one good relative to another.

Opportunity cost is a key concept in economics because it implies the choice between desirable, yet mutually exclusive results. It is a calculating factor used in mixed markets which favour social change in favour of purely individualistic economics. It has been described as expressing "the basic relationship between scarcity and choice." The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, swag, pleasure or any other benefit that provides utility should also be considered opportunity costs.


A person who has $15 can either buy a CD or a shirt. If he buys the shirt the opportunity cost is the CD and if he buys the CD the opportunity cost is the shirt. If there are more choices than two, the opportunity cost is still only one item, never all of them.

A person who invests $10,000 in a stock denies herself or himself the interest that could have accrued by leaving the $10,000 in a bank account instead. The opportunity cost of the decision to invest in stock is the value of the interest.

b) Arc Price Elasticity:

When we try to use the equation in the first section to calculate elasticity coefficients, we run into a problem. If we look at an increase in price from $3.00 to $4.00, we have an increase of 33%. However, if we have a price reduction from $4.00 to $3.00, we have a reduction of 25%. Thus, there are two ways of viewing what happens between $3.00 and $4.00.

Suppose that when price of a product is $3.00, people will buy 60, but when price is $4.00, they will buy only 50. What is the elasticity over this segment of the demand curve, between prices $3.00 and $4.00? Should one start at the price of $3.00 and compute a price rise of 33 1/3% and a quantity decline of 16 2/3%,

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